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In any period or extended period of solid growth in real estate, you’ll start hearing a lot of news coming out about house flippers and people doing exceptionally well in real estate.

And it is true; people do fabulously well by selling homes.

But there are some cautions and flags you need to be aware of if you’re thinking about getting into house flipping.

Is house flipping a viable investment option?

In short, yes.

But house flipping isn’t viable for everyone.

The media makes it sound like everyone who tries flipping houses has incredible success.

But you should remember, nobody gets on radio and television to talk about how badly they did in real estate.

In statistics, they call this “adverse selection”. It’s when you only see one side of the equation.

With house flipping and real estate, you only see the positive side. Because as I said, nobody wants to go on TV and tell people how much money they lost.

These positive stories tweak that fear of missing out we all experience. As soon as you feel like everyone else is doing it, you feel like you’ve missed out.

But what is house flipping?

Let’s define it.

House flipping means buying real estate and holding it for a short period to realise profits.

You’re not going to live in it. You don’t necessarily care that much about the property, at least not as much as you would if it was your own home. You just want to generate a profit from it.

House flipping usually occurs due to two aspects.

One is when we have a booming real estate market.

The other is “doing up” or adding capital gains to the house. That’s completing renovations and various upkeep.

Now, that doesn’t mean you have to renovate the house to flip it.

In a booming market, many people grab houses and resell without doing any renovations.

Other people buy in a booming market and do lots of renovations.

You could argue that the upgrades added no value, and it was just the appreciation and the real estate market in general that made them the money, but it’s hard to know for sure.

Why does house flipping work?

One of the reasons house flipping works is because of leverage. If you add value to the property, you make money because you’ve leveraged your value or cash down versus what you can buy.

Say you go in to buy a $1 million property.

You have $100,000 (your cash down). That’s all you need to get a mortgage. So, you put that $100,000 down to buy the $1 million property. That means you’ve borrowed $900,000.

Now you own a million-dollar property with only 10% of actual cash.

A short amount of time later, say six months, you sell that property for $1.2 million. So now, prima facie, you’ve made $200,000 on the million. But you haven’t.

You only put $100,000 into it. Your loan was $900,000. So, you walk away with $300,000. You have made $200,00 from a $100,000 investment. That’s a huge return. It’s an excellent investment over a brief period.

Is it mainly about the right renovations?

No one can tell if the best returns are from making the right capital gains.

I suspect many people are just making money on the market and property values rising without renovations.

But it doesn’t come without risks.

What are the risks?

I’ve got five risks. Let’s go through them.

1.   Taxes, fees, and other costs.

Often, people only think about the upside.

You can make $200,000 from a $100,000 investment. Sounds great.

Well, it’s not that cut and dry. There are costs. You may need to pay LMI if you only put that 10% down. There are financing costs and closing costs. You’ve got to pay your real estate agent, council costs, upkeep costs, insurance, maintenance.

There are, of course, substantial government taxes as well.

So, really, how much did you really make? It wasn’t $200,000.

People tend to forget about the costs taken from their return and only talk about the profit. So, costs are something to keep in mind.

2.   Time spent.

For house flippers (and buyers), an awful lot of time is spent on finding the right property, negotiating the right price, working through the mortgage details, and talking to your mortgage lender or mortgage broker, among other things.

Then you can spend a massive amount of time renovating, project managing, then walking back through the entire process when you’re selling it.

It takes a lot of time.

Some people have done a cost average on the amount of time it cost them to do this, and they’ve said it would have been better if they just kept working. So that’s something to think about.

The amount of stress you get from putting that much time, focus, and energy into buying and selling this property can be enormous.

3.   Local knowledge.

Now, many people say in a hot market; you don’t need to know anything.

I disagree.

Even in incredibly hot markets, some places are great to buy, and others are terrible.

An example might be that the government is building a new highway.

A new highway can be good for the suburb that it’s emptying close to because now those houses may have access to all the main thoroughfares and the city. Then, suddenly, the value of that property, and the properties in that neighbourhood, will go up.

But what if you’re in a property that is right next to this new highway? You hear all the noise from the highway. So your property value will go down, and it’s going to be challenging to sell.

That’s just knowing the market.

Knowing where developments are happening, where the council will build infrastructure, and where government investments are being implemented is very important when it comes to making a good purchasing decision.

Don’t go into this blindly. You can get this information from the government.

4.   Skill knowledge.

A lot of people who go into house flipping have hands-on knowledge.

They’re plumbers, electricians, or just very handy people. They know how to renovate the house. They can improve the property themselves, or they have industry contacts who can do it for them at a great price.

Someone without those connections or skills knowledge is going to spend a lot more money on renovations.

If you’re going into house flipping without any skills, I’d have a serious second thought about doing it.

5.   Patience.

Patience applies to almost all investments. You need to wait for the right time and the right place.

People in the house flipping game have told me that the newbies are so excited about the profit, enthusiastic about starting, and excited about making money that they rush and buy quickly.

Estate agents can see you coming.

House sellers can see you coming.

You’re going to get taken advantage of. So, don’t rush and buy. Instead, take the time, and you can avoid making a bad economic decision.

House flipping is a good business.

Most of these facts, but mainly the first four, are a real insight into the type of game house flipping is.

It can make you question: is house flipping an investment game, or is it a business?

Personally, I think it’s a good business.

If you have the right business skills, then you’re thinking about the costs.

To be successful, you need to have the proper knowledge, have the right skills, and understand negotiation.

You must understand how to deal with mortgage brokers and developers. You have to deal with estate agents.

It’s hugely complex. You can’t just rush into it thinking you know it all.

You learn a lot more by doing and making mistakes along the way, and many people can’t risk making those mistakes.

Even people with a lot of expertise will still make mistakes.

Is it a viable investment? Yes. But it’s also a viable business. So you should enter it with a lot of caution, unless you’re very business savvy. If you don’t have that knowledge, there are better investment strategies.

And like all businesses, there are downsides.

But you are not running a business when you’re investing in the stock market.

When you see people who are successful with house flipping, you usually will see a savvy businessperson, rather than an investor.